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“Incoming Federal Reserve Chair Jerome Powell has a tough job in front of him. He inherits sky high asset valuations and an economy growing above potential. He also has a president who sees the wealth created from the rise in these asset prices as the crowning achievement of his thus far controversial presidency. Will he be the next Arthur Burns, the Fed chair who was heavily influenced by President Nixon? Or will he fiercely defend the Fed’s independence? We believe the latter, and will soon find out. But Powell seems to have little upside.

“The US economy is firing on pretty much all cylinders and there is little spare capacity left in the economy – especially when you factor in the impact of recently-legislated tax reform – so the potential for inflation to start to rise sharply from here is high. There is a feasible scenario where Powell might have to look at this rise in inflation and sacrifice economic growth to maintain the Fed’s inflation-targeting credibility. That wouldn’t make him very popular with the president, who has sought to take much of the credit for the stock market rally and broader economic strength. It will be very interesting to see over the course of the next year if that scenario becomes reality.

“The market is not pricing in this outcome. Instead, it sees a Federal Reserve happy to keep financial conditions loose and the economy running hot – aided by recent speculation that the Fed may change its mandate to target inflation of 1.5-3.0%. We believe Powell will continue what Yellen started – tightening monetary policy to counter rising demand for credit in an economic upswing. As a result, we see US Treasury yields rising further from here and a vulnerable stock market.”